Great blog posts about macroeconomics

Nonsensical Government Spending: Fossil Fuel and Sugar Subsidies

The way in which the government spends the taxpayer’s money is always a hotly debated political issue. Typically, we expect the government to spend money on things that help the people, and tax the things that hurt them. Yet this is not always the case. Often due to political forces, government spending falls out of line with economic logic. Sometimes, government spending completely contradicts economic theory. In this post, I will examine two cases in which the government subsidizes an industry, when in reality, it should be taxed. These examples are fossil fuels and sugar.

Before these cases are investigated, it is best to review why the government would tax or subsidize an industry. Both taxes and subsidies attempt to use market forces in order to correct market failures. In the case of subsidies, there is a benefit, or a positive externality, that is not captured in the price system, and therefore the equilibrium quantity produced or consumed is too low. To correct this, the government provides some kind of financial assistance to an industry in order to incentivize more production of that good. One example of this is student loans. It benefits all of society if more people are highly educated, but this benefit is not captured in the price system. To correct this, the government provides affordable loans so that more people can go to college and get educated. This makes them more productive members of society and better democratic citizens. With the case of taxes, there is a cost, or a negative externality, that is incurred on society but not reflected in the price system. As a result, the equilibrium quantity produced or consumed is too high. To fix this, the government will tax an activity to lower the quantity that is produced or consumed. An example of a negative externality is smoking. Smoking is deleterious to the health of the smoker and those that live around the smoker. But the health costs associated with smoking are not captured in the price of cigarettes. Taxes correct this market failure by increasing the price of cigarettes and discouraging smoking. This all seems straightforward, but in the cases of fossil fuels and sugar, the government is spending money to subsidize these industries when they should be taxed.

Sugar creates a negative externality because over consumption leads to major health problems. When people buy sugar at the grocery store, the price does not reflect the health care costs associated with solving obesity-related illnesses. It is estimated that in the United States alone, obesity related illnesses cost $147 billion per year. Despite this, the federal government has been subsidizing the production of sugar since 1934, and continues to do so today. The main way in which the government subsidizes sugar is by providing loans to sugar farmers, and allows them to repay their loans with raw sugar if the market price drops below 20.9 cents per pound. In 2000-2001, this program was estimated to have cost nearly half a billion dollars. Effectively, this is a massive government purchase of sugar, which increases the price of sugar for US consumers. This subsidy allows US sugar farmers to compete with other countries that can produce sugar more cheaply. Instead of wasting taxpayer money to prop up an industry that cannot compete with the global producers, the government should eliminate the sugar subsidy. That would save the explicit cost of the loan program. Additionally the government should tax the consumption of sugar to reduce the implicit health care costs associated with the overconsumption of sugar and the obesity related illnesses that result.

The fossil fuel industry is another case in which the government should tax, rather than subsidize, an industry. It is estimated that total government subsidies for fossil fuel production is worth roughly $4 billion. The government advocates for such subsidies because it allows the US to remain energy independent. While it is benevolent to ensure that everyone can afford energy, there are other ways to achieve this without encouraging the proliferation of negative externalities. The main negative externality that results from fossil fuel production, is obviously, greenhouse gas emissions which exacerbate climate change. Climate change imposes a multitude of costs, including desertification that destroys farmland, rising sea levels which destroy properties and more intense natural disasters which destroy lives. Instead of spending $4 billion to subsidize the production of fossil fuels, the US could subsidize renewable energy technologies to create energy independence. Also, the US should tax the consumption of fossil fuels in order to include carbon in the pricing system. This would reduce the quantity of fossil fuels that are produced, and decrease the equilibrium quantity towards the socially optimal level. This would mitigate the costs that are linked to climate change. Both cases of sugar and fossil fuels show how government spending policy can be out of line with economic theory.

With our economy being so oil dependent, it seems important for us to not be totally reliant on foreign oil production. While taxing oil would theoretically decrease consumption (similar to cigarettes), we have to remember that oil is a necessity, whereas cigarettes are not. On the micro scale, people who work minimum wage jobs and rely on their car to get to work, an oil tax would be a heavy added burden. Because of this I think the decrease would have limits on its effeciveness, and although it would likely cut down on waste, taxing something so central to our economy could have significant unforeseen consequences.